Pete the Banker: Novick Looks to Bankrupt City for Portland Ideas

Portland Commissioner-elect Steve Novick is looking toward bankrupt San Bernardino, California for ideas on how to help underwater home owners in Portland and one idea in particular is a real doozy.

Novick says the idea of the city condemning a house mortgage and then re-selling it is nothing short of "brilliant." Here's what he told the Zero:

"The detail devil, of course, would be identifying criteria for determining which mortgages might be subject to eminent domain," he writes in an email. "I think it's possible that a program like that, even if rarely used,

could be a useful supplement to the new foreclosure mediation program. If homeowners and lenders knew that under certain circumstances, the local government might use eminent domain in this way, it would strengthen the homeowners' bargaining power in those mediations."

The idea belongs to Robert Hockett, a Cornell University law professor, and was recently touted by Robert Schiller of Yale University. He's the author of the Case-Schiller Index, a well regarded barometer of the housing industry.

Professor Hockett argues that a government, whether federal, state or local, can start doing just this right now, using large databases of information about mortgage pools and homeowner credit scores. After a market analysis, it seizes the mortgages. Then it can pay them off at fair value, or a little over that, with money from new investors, issuing new mortgages with smaller balances to the homeowners. Taxpayers are not involved, and no government deficit is incurred. Since homeowners are no longer underwater and have good credit, they are unlikely to default, so the new investors can expect to be repaid.

The original mortgage holders, the investors in the new mortgages, the homeowners and the nation as a whole will generally be better off. There will surely be some who may not agree, like the holdout farmer opposing the highway, but eminent domain ought to be able to push ahead anyway.

A recent Wall Street Journal op ed editorialized against this action, because of course, there will be blow back on the taxpayers and the law. CNBC wrapped up the arguments:

In this instance, the government has every economic incentive to underpay the investor who owns the mortgage to cover transaction costs and boost returns for itself and MRP. Even worse in this case, the government would be grabbing mortgages on which the homeowner is still paying the monthly rent, not mortgages that are in default or close to it. It's an arbitrary seizure.
It also argues that this would put in question the values of all home loans, which could hurt home prices and keep private investors from returning to the mortgage market (not that they're coming back in droves now as it is)." 

While the concept of using eminent domain to try to fix the underwater housing market is interesting, the idea of morphing the law to accommodate a self made problem is anathema. Best to let the market bottom out of its own accord and begin to rebuild hoping all the time that we don't do this to ourselves again.